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Power IPOs: Stretching it too far

Dec 7, 2009

India needs a lot of power over the next few years. There are no two ways about it. That the country can face a tough future if nothing is done on the power front is a widely known fact. Something needs to be done urgently if we are to maintain our high GDP growth numbers over the next many years.

While the government and private sector realise this fact, things are still very slow on ground. This is justified by the fact that we still add less than 5,000 megawatts (MW) of new capacity every year. As compared to this, China adds around ten times this capacity annually!

Now while India continues to suffer a grave power deficit, we are seeing a spate of new players entering the fray. And the way they are doing this is by way of raising fresh capital from the stock markets. We have seen three large power sector IPOs since the start of this year. These have been from Adani Power (July), NHPC (August) and Indiabulls Power (October). Another company - JSW Energy - is launching its IPO today.

While there are several differences in the businesses of these companies, one thing remains common. High valuations at which their IPOs have been priced. This is when some of these like Adani Power and Indiabulls Power had no prior history of operating large power plants and therefore suffered from huge execution risks. While it is not to say that existing power players coming with their IPOs do not face such risks, but experience plays a big part in the success of a power venture.

Coming back to these new kids on the block, they face a number of issues in developing their power projects. Such issues range from regulatory and environmental approvals, land acquisitions, and fuel and equipment supplies. All these may result in cost overruns of projects thereby impacting future cash flows, in anticipation of which these IPOs have been priced high in the first place!

There is no denying that some of these companies might earn big bucks in the future as their projects come on stream. But would this mean big bucks for investors is highly doubtful. This is because these companies will require lots of capital over the next few years that will most likely stretch their balance sheets.

As such, a lot of money that will be generated through these power projects will ultimately go back to fund expansion of these projects. A little will come back to the investors either in terms of high return on equity or in terms of dividends.

Anyways, those who have applied to these power sector IPOs have already started on a weak base. This is given that they have picked up these stocks at high valuations, which is not the right way to go about investing in stocks.

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